"Mercenary Geologist" Michael S. (Mickey) Fulp's 29 years of field experience as an economic geologist evaluating exploration and mining projects throughout the Americas and China make him uniquely qualified to give The Gold Report an intriguing overview of what's happening now in gold, precious metals and rare earths, and uranium. Mickey, always on the lookout for companies with the right share structure, people, and projects, is a proponent of the “Boot Leather and Drilling” style of exploration. He gives us a quick tour of his take (and favorite stocks) in the sector.
The Gold Report: On your website, it says you look for stocks that can double share price in 12 months or less. Is that still true in this bear environment?
Mickey Fulp: Most definitely. It’s not so easy to pick those doubles now, but I certainly think that should always be the goal in speculative resource stocks. I’ll pick stocks that I think will double in 12 months or less and stick to the way I’ve always traded; that is, when those stocks double, I sell half of my position plus enough to cover my brokerage fee; then I’m playing with the house money with a zero cost basis and half my original position. Then I take that money and do it again on another stock.
TGR: I know that you wear several hats, and I want to start with your global economy hat. What are you seeing in terms of precious metals, and how they’ll be reacting in the bear environment? Can you give me an overview of what you see happening in gold?
MF: I’m looking here on my KCAST (Kitco) gold, and it’s $753 an ounce as we speak. I think $750 is a viable price for legitimate gold producers. It’s unknown how gold will react in a deflationary environment. We’ve never really experienced a deflationary environment in modern times when the price of gold was floating because, when the Great Depression started, gold was $20.67 an ounce. Roosevelt raised that to $35 an ounce in 1933, made it illegal to own privately, and the price of gold was fixed throughout the Depression and until Nixon’s debacle in 1971.
Arguably, we are in a deflationary environment right now. I personally think we’re in a depression. At some point, with the Fed creating money willy-nilly and the U.S. government bailing out all the failed financial institutions, we’re going to look at a hyper- inflationary environment; and we all know that bodes well for the price of gold.
TGR: We’ve talked about the bailout here in the U.S., but there are also forms of bailouts happening in Europe and China. If every government is inflating its currency …
MF: That’s very true.
TGR: Worldwide, doesn’t that kind of equalize?
MF: Well, you can make that argument, but it’s hard to know which currency is going to come out on top on this. Probably none because they are all fiat with no hard asset basis. Certainly, fiat currencies in nearly every country are in a world of hurt right now. We just saw the Chinese devalue its currency—what was it—6% this week? Yes, it does even out, and the price of gold will rise with hyper inflation.
TGR: Let’s switch over to silver and other precious metals. Are you focusing just on gold or do you think there’s also a play for silver, palladium, platinum?
MF: I don’t have a strong opinion on platinum and palladium because they are so driven, no pun intended, by the auto catalyst market and with the downturn in automakers worldwide, that does not bode well for those two metals. On the other hand, they certainly have value as precious metals. Silver is also a bit of both. It’s both an industrial metal and has some value as a store of wealth. One thing I’ve looked at lately (and I’ve actually been a buyer of physical silver for the last couple of months or so), is the gold-silver ratio. Whenever it gets high, as it is right now, I consider that a buying opportunity in silver.
There’s been a lot of press about silver not being available, but silver is available in large bars. You can buy a 1,000 ounce bar through COMEX and take delivery on a January contract now—for somewhere around 25 cents over the spot price, if you pick the right broker. When I see the gold-to-silver ratio go above 80, I consider that a buying opportunity for physical silver.
TGR: We always hear that silver has more swings than gold and it will lag gold when gold starts to go up.
MF: It does have wider swings and that gives it some more volatility on both the upside and the downside. I look at that as a way to make money. Because of its volatility, it could lag gold on the way up; if it does, then the ratio gets out of whack. Historically, the ratio was 16:1. When gold and silver were both floated on the open market that ratio grew. Over the past 10-15 years it has been somewhere between about 40 and 70. As we speak right now, it’s 80.
So you can play sort of an arbitrage; the increased volatility of silver compared to gold gives you some leverage, much the same as playing junior resource stocks gives leverage on both the upside and the downside vs. the price of gold. Junior resource stocks will go up and down with much more volatility than the price of gold, so that’s how we end up with the proverbial five or ten baggers. In this environment, those five and ten baggers can be negative five and ten baggers. But at some point, resource stock valuations get so low that good companies—especially those with current gold production or near-term production, positive cash flow, and in particular, takeover targets—are ridiculously undervalued.
TGR: In your newsletter, Mercenary Musings, do you talk about buying physical gold and silver or do you focus on equity investments?
MF: I focus on many things, including stocks, educating investors, markets and macroeconomics, commodities, libertarian ideals, my field adventures, etc. I’m not a certified financial analyst. I’m a geologist with nearly 30 years experience. I basically tell people what I have done, or am doing, in the market. For instance, when I find a stock I like, I may say I’m accumulating this right now; I like this about that, etc. So my newsletter is quite varied.
TGR: We were talking earlier about palladium and platinum and I noticed that one of the companies you have in your technical analysis is Avalon Ventures Ltd. (AVL: TSX-V). I believe that’s a rare metals company.
MF: Yes, it is.
TGR: Would you talk a little bit about your viewpoint of rare earth elements, kind of global economics, and the importance it will play or the downside it will face given the recession that we’re all going through?
MF: That’s a very good question. Rare earth elements are increasingly used for high-tech applications, specifically super magnets and batteries. They are in short supply because in the late '80s and early '90s, the Chinese developed a very robust deposit in Northern China and, basically, they cut out all the established world producers by drastically lowering prices. They now supply over 90% of the world’s rare earth elements. These metals are critical for hybrid cars and large commercial air conditioning systems; they’re also used extensively in high-definition LCD TVs and electronics technology. For example, cerium provides the red color for your little LCD headlamp. So there’s a bunch of varied high-tech uses for these metals. Certainly demand for those things is dependent on a viable world economy.
Avalon’s in an interesting position, as it has a unique deposit in the Northwest Territories about hundred kilometers East-Southeast of Yellowknife. The Thor Lake deposit is concentrated in the heavy rare earth elements. Rare earth elements are kind of a mixed bag of 16 elements (15 plus yttrium), and they always occur together. Avalon’s deposit is unique in the fact that, in this series of 15 elements on the periodic chart from atomic number 57 to 71, the heavy rare earth elements are much more rare than the light rare earths.
As a result, they are in greatly increased demand and they trade at very high values, hundreds of dollars per kilogram in some instances. So I’m bullish on the long-term prospects for Avalon. It’s really been beaten up lately with a year high of $1.97, a year low of about 35 cents; currently it’s at 40 cents. It made a rally a couple of months ago and has gone south since then. The key to Avalon is they have a deposit that is potentially economic outside the Chinese supply monopoly. They are being courted as we speak by Japanese auto makers because the Japanese cannot depend on the Chinese for a supply of rare earth elements. The Chinese have put on export quotas and taxes because, as much as possible, they want to keep all their production in China and develop processing facilities there. They consume about 60% of the world’s rare earths.
TGR: You said earlier the key to the deposit of Avalon is to make it viable outside the Chinese monopoly. It sounds to me that, given the two facts you stated immediately afterward, it's going to be clear imminently.
MF: It’s going to be clear soon because Avalon is working on a resource estimate as we speak that will include drilling through last winter. They drilled this summer with great success, and they will come back with a second resource estimate and a process metallurgical report, probably by the end of the first quarter of next year, and then move on to a pre-feasibility study. So, assuming we have a viable world economy—and, arguably, that’s questionable right now—I would look at Avalon as in play, if you will, or looking to secure an off-take agreement for its production with a Japanese company sometime in 2009.
TGR: When will it start producing?
MF: I think they’re still about four years away from actually constructing a mine and getting it into production. The climate up there is northern boreal forest and water or ice, so for the construction phase, it’ll be a seasonal operation.
TGR: Are there other potential prime geological territories that might produce these rare earth metals?
MF: The area that comes to mind, of course, is Mountain Pass, which is in southeast California. It dominated world production until it was cut out by the Chinese. It’s just sitting there, held by Unocal with something like 20 million tons of nearly 8% to 9% in dominantly light rare earths, so this is a bit of a different market than what Avalon would be courting because Thor Lake is a heavy rare earth element deposit. There’s also a deposit in Australia, Lynas Mining’s Mt. Weld, concentrated in neodymium and it could dominate the supply of neodymium.
TGR: Is that in production?
MF: No, but it is in development and pending completion of concentrating and materials plant facilities. The rare earth elements themselves are not particularly rare, but the deposits that concentrate them in minable quantities are extremely rare worldwide.
TGR: I also see, when looking at your Mercenary Musings online, that you had a recent Musing regarding Animas Resources (TSX.V:ANI). What caused you to write about that specific company?
MF: Well, as with most of the things I cover, I put my Mercenary money where my mouth is. I was an IPO investor of Animas Resources. I still hold the warrants. It’s a story I have followed since inception. I have a bit of a mantra about a good company; it’s got to have the right share structure, people, and projects. And, in my view, Animas has all three of those.
It’s a Carlin-type system in Northern Mexico, having produced 650,000 ounces of gold in the 1990s, and then shut down in 2000, because of a depressed gold price of $300 an ounce. It shut down with an historic resource, not 43-101 qualified and I need to make that clear, of 718,000 ounces. It has the geologic characteristics of Carlin-type systems in northeast Nevada and, in my Musing, I list 10 of those.
It’s never been drilled deep, and it’s never been drilled systematically under gravel cover adjacent to the 12 small deposits that were mined in 22 separate pits. So it’s historically been a district—and Animas controls the entire district—that has produced from small deposits. Management at Animas includes a "who’s who" of senior-level geologists who have worked for major mining companies. One of its consultants is Odin Christensen. Odie was Chief Geologist for Newmont Mining Corp. (NYSE:NEM) in the Carlin Trend when it first was drilled deep. And huge, deep high grade gold deposits were found, which really made the Carlin Trend. I see the same geological characteristics at Santa Gertrudis. The management is good; low number of shares outstanding—less than 27 million shares; very tightly held. It hit an all-time low at 29 cents today; it’s very encouraging that the entire management and controlling group of this company has never sold shares or exercised options. They obviously like the project and intend to play it out.
It’s strictly an exploration play. I don’t like very many exploration plays right now; but, with working capital at $4.5 million, they can go at least to early 2010 and give Santa Gertrudis their best shot. If they find big, deep, high-grade Carlin-style deposits, they will be in play as a takeover candidate. If they don’t, they have other options. There are lots of small miners in Mexico, small junior companies mining less than 100,000 ounces a year in that region. Animas has six different projects in the district and it could JV some of them out to people that want to mine on a smaller scale.
TGR: We covered gold, precious metals and rare earths, and uranium. It’s been quite a tour around the world here very quickly.
MF: I have one other gold company that I like—PDX Resources Inc (TSX:PLG), formerly called Pelangio Exploration.
TGR: What’s caused you to focus on this one?
MF: I followed the story for quite some time, did my detailed due diligence, and became a shareholder. PDX owns 19 million shares of Detour Gold (TSX:DGC); the Detour Lake gold property in Northern Ontario. Detour Gold, at a $700 gold engineered pit, has 10.75 million ounces of gold resource. That’s measured and indicated resource. That’s always important—measured and indicated. It has some additional inferred, but I don’t pay much attention to inferred resources.
If you do the math, Detour Gold is now being valued at over $15 per ounce of contained gold. PDX Resources owns 42.4% of Detour Gold shares and their valuation now is $10.50 an ounce. Detour Gold is in the final throes of a feasibility study. It was scheduled to be out by the end of this year; I do not know if they’re presently on schedule for that, but they become a takeover candidate with a positive feasibility. You have leverage there for PDX shares vs. Detour Gold shares, at a 30% discount per ounce of gold in the ground.
TGR: But you’re saying Detour is the potential takeout candidate?
MF: Yes, it is.
TGR: Isn’t this what you mentioned earlier, where the only potential company that would take them out because of their share structure is PDX?
MF: No, PDX Resources originally spun out 50% of the deposit to a new entity, Detour Gold, a Hunter-Dickinson company and now exists only as a shareholder of Detour Gold. It is the minority shareholder, and is comprised of expert explorationists. So recently in September, it spun out all its other properties into a new exploration company, which is Pelangio Exploration; thus PDX holds its Detour Gold shares solely for investment purposes. With 10.75 million ounces, this is a huge deposit; it was a past producer of Placer Dome. It failed because of a low gold price in the previous downturn in the gold business. I think you’re probably looking at a bidding war for Detour Gold.
Goldcorp (TSX:G) (NYSE:GG) is the obvious candidate and we saw what Goldcorp did with its acquisition of Gold Eagle in the Red Lake District. Kinross Gold Corp (K.To) (NYSE:KGC) is a possible suitor. With this size of deposit, you’ve got to throw in the big boys—Barrick Gold Corp (NYSE:ABX), Newmont, Anglo, Gold Fields Ltd. (NYSE:GFI)—and some of the mid-tier gold companies looking to become major producers. It’ll get taken out at the Detour Gold share price, which is now trading at $15 per ounce of gold in the ground, while PDX is currently trading at $10.50. That’s 30% discount, so you have leverage to the upside with PDX Resources. Make sense?
TGR: That’s a great and very interesting play. Mickey, thank you for your time.
Michael S. “Mickey” Fulp, who launched MercenaryGeologist.com in late April 2008, brings more than 29 years of experience to his role as an exploration geologist. Specializing in geological mapping and property evaluation, Mickey has worked as a consulting economic geologist and analyst for junior explorers, major mining companies, private companies and investors. Check out his website for free access to the Mercenary Musings newsletter, as well as technical reports. Future offerings will include a premium paid subscription service that provides early and special access to subscribers. You may contact him at [email protected] .
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